Actually writing your own JVM with any kind of license is completely valid. AFAIK reasons for creating dalvik were technical (which are not so relevant anymore).
The problem point is possibly the partial JDK they are using. Android uses pieces of an apache licensed version of JDK called Harmony. And they avoid using the word "JDK" for that subset. The only point i can think that Google may be in trouble is that Harmony may include Sun JDK's code in it. It is bad because their licenses are not compatible.
But i doubt that is the attack point of Oracle and nevertheless i believe they will fail and lose a lot of credibility from developers. For once, Google makes Java relevant in mobile world, and they use it heavily in their internal applications.
I would much prefer Oracle to join Google on Android development instead of playing dirty.